Incorporating Diagnostic Expectations into the New Keynesian Framework

Jean-Paul L’Huillier, Sanjay Singh and Donghoon Yoo ()

The Review of Economic Studies, 2024, vol. 91, issue 5, 3013-3046

Abstract: Diagnostic expectations constitute a realistic behavioural model of inference. This paper shows that this approach to expectation formation can be productively integrated into the New Keynesian framework. Diagnostic expectations generate endogenous extrapolation in general equilibrium. We show that diagnostic expectations generate extra amplification in the presence of nominal frictions; a fall in aggregate supply generates a Keynesian recession; fiscal policy is more effective at stimulating the economy. We perform Bayesian estimation of a rich medium-scale model that incorporates consensus forecast data. Our estimate of the diagnosticity parameter is in line with previous studies. Moreover, we find empirical evidence in favour of the diagnostic model. Diagnostic expectations offer new propagation mechanisms to explain fluctuations.

Keywords: Heuristics; Representativeness; General equilibrium; Shocks; Volatility (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Incorporating Diagnostic Expectations into the New Keynesian Framework (2023)
Working Paper: Incorporating Diagnostic Expectations into the New Keynesian Framework (2023)
Working Paper: Incorporating Diagnostic Expectations into the New Keynesian Framework (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:91:y:2024:i:5:p:3013-3046.

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